Net Revenues and Cost of Sales
We derive our revenues primarily from sales of INVOS Systems to hospitals in the United States through our direct sales team and independent sales representative firms, although we expect to derive modest revenues in fiscal 2009 from our newly-acquired data integration technology, which we plan to launch as a stand-alone device in mid-2009 through our direct sales team. Outside the United States, we have distribution agreements with independent distributors for the INVOS System, including Covidien, formerly Tyco Healthcare, in Europe, Canada, the Middle East and South Africa, and Edwards Lifesciences Ltd. in Japan. Our cost of sales represent the cost of producing monitors and disposable sensors. Revenues from outside the United States contributed 20 percent to our fiscal 2008 net revenues. As a percentage of net revenues, the gross margins from our international sales are typically lower than gross margins from our U.S. sales, reflecting the difference between the prices we receive from distributors and from direct customers.
We recognize revenue when there is persuasive evidence of an arrangement with the customer, the product has been delivered, the sales price is fixed or determinable, and collectibility is reasonably assured. The product is considered delivered to the customer once we have shipped it, as this is when title and risk of loss have transferred. Payment terms are generally net 30 days for U.S. sales and net 60 days or longer for international sales.
Our INVOS System revenues are derived from the sale of monitors and our disposable sensors. We intend that disposable sensors will form the basis of a recurring revenue stream. In addition, we offer to our customers in the United States a no capital cost sales program whereby we ship the INVOS System monitor to the customer at no charge. Under this program, we do not recognize any revenue upon the shipment of the monitor. At the time of shipment of the monitor, we capitalize the monitor as an asset and depreciate this asset over five years, and this depreciation is included in cost of goods sold. We recognize sensor revenue when we receive purchase orders and ship the product to the customer.
Operating Expenses
Selling, general and administrative expenses generally consist of:
• salaries, wages and related expenses of our employees and consultants;

• sales and marketing expenses, such as employee sales commissions, commissions to independent sales representatives, travel, entertainment, advertising, education and training expenses, depreciation of demonstration monitors and attendance at selected medical conferences;

• clinical research expenses, such as costs of supporting clinical trials; and

• general and administrative expenses, such as the cost of corporate operations, professional services, stock compensation, insurance, warranty and royalty expenses, investor relations, depreciation and amortization, facilities expenses and other general operating expenses.

We have increased the size of our direct sales team from 44 persons at the end of fiscal 2006 to 55 persons at the end of fiscal 2008. We expect to increase the size of our U.S. direct sales team in fiscal 2009 and are planning to hire direct salespersons and clinical specialists in Europe to support Covidien. We also expect increased sales and marketing expenses and increased stock compensation expenses in fiscal 2009. As a result, we expect selling, general and administrative expenses to increase in fiscal 2009.
Research, development and engineering expenses consist of:
• salaries, wages and related expenses of our research and development personnel and consultants;

• costs of various development projects; and

• costs of preparing and processing applications for FDA clearance of new products.

For the fiscal year ended November 30, 2006, we recorded a research and development expense of $1,000,000 in connection with our former contract development and exclusive licensing agreement with NeuroPhysics Corporation.

We expect our research and development expenses to increase in fiscal 2009 as a result of development costs associated with our newly-acquired data integration technology, development costs associated with our Contract Development Agreement with Shirley Research Corporation and the addition of research and development personnel.
Deferred Tax Assets and Impairment Charges For the fiscal year ended November 30, 2006, we adjusted our deferred tax asset valuation allowance resulting in the recognition of additional deferred tax assets due to expected future tax benefits related to our net operating loss carryforwards. Recognition of this additional deferred tax asset resulted in a non-cash net tax benefit on our statement of operations for fiscal 2006 of $750,000.
For the fiscal year ended November 30, 2007, we recognized income tax expense at an estimated effective tax rate of 35 percent on our statement of operations. This income tax expense included a non-cash tax expense on our statement of operations for fiscal 2007 of $5,076,276. In November 2007, we wrote off obsolete inventory of $180,521.
For the fiscal year ended November 30, 2008, we recognized income tax expense at an estimated effective tax rate of 36 percent on our statement of operations. This income tax expense included a non-cash tax expense on our statement of operations for fiscal 2008 of $5,586,906. In addition, during fiscal 2008 we recognized deferred tax assets related to the exercise of stock options of approximately $1,012,000. These assets were recognized in additional paid in capital on our balance sheet because they were utilized and reduced current taxes payable.
Results of Operations
Fiscal Year Ended November 30, 2008 Compared to Fiscal Year Ended November 30, 2007
Net Revenues. Our net revenues increased $8,869,785, or 23 percent, from $38,585,832 in the fiscal year ended November 30, 2007 to $47,455,617 in the fiscal year ended November 30, 2008. The increase in net revenues is primarily attributable to:
• an increase in U.S. sales of $6,474,215, or 21 percent, from $31,560,930 in fiscal 2007 to $38,035,145 in fiscal 2008. The increase in U.S. sales was primarily due to an increase in sales of the disposable sensor of $5,619,820, or 23 percent, primarily as a result of a 16 percent increase in sensor unit sales. In addition, sales of the INVOS System monitor in the United States increased $932,969, or 14 percent, primarily as a result of increased purchases by pediatric hospitals; and

• an increase in international sales of $2,395,570, or 34 percent, from $7,024,902 in fiscal 2007 to $9,420,472 in fiscal 2008. The increase in international sales was primarily due to increased purchases of our INVOS System monitor and disposable sensors of $1,655,456 by Covidien in Europe, and $686,471 by Edwards Lifesciences in Japan. In fiscal 2008, international sales represented 20 percent of our net revenues, compared to 18 percent of our net revenues in fiscal 2007. Purchases by Covidien accounted for 14 percent of net revenues in fiscal 2008, compared to 13 percent in fiscal 2007.

In the United States, we sold 288,797 disposable sensors in fiscal 2008, and internationally, we sold 135,850. We placed 517 INVOS System monitors in the United States and 621 internationally in fiscal 2008, and our installed base of INVOS System monitors in the United States was 2,523, in 714 hospitals, as of November 30, 2008.

Sales of our products as a percentage of net revenues were as follows:

                                        Fiscal Year Ended November 30,
             Product                       2008                 2007
             Sensors                            72 %                  73 %
             INVOS System Monitors              28 %                  27 %

             Total                             100 %                 100 %

We believe that the current economic downturn in the United States and abroad could significantly lengthen the sales cycle for our products and reduce the growth in our net revenues in fiscal 2009.
Gross Margin. Gross margin as a percentage of net revenues was 87 percent for the fiscal year ended November 30, 2008 and 88 percent for the fiscal year ended November 30, 2007. The decrease in our gross margin percentage is primarily attributable to increased international sales, due to lower margins we receive on sales to our international distributors. This decrease was partially offset by a six percent increase in the average selling price of disposable sensors in the United States, which is attributable to increased sales of our pediatric sensors, which sell for a higher price than the adult sensor.
Research, Development and Engineering Expenses. Our research, development and engineering expenses increased $590,412, or 88 percent, from $668,815 in fiscal 2007 to $1,259,227 in fiscal 2008. The increase is primarily attributable to an increase in salaries of $279,487 due to the addition of research and development personnel in fiscal 2007 and 2008, and increased costs associated with advances to the design and performance features of our INVOS System monitor and disposable sensors of $214,803. We expect our research, development and engineering expenses to increase in fiscal 2009 primarily as a result of development costs associated with development of our newly-acquired data integration technology as a stand-alone device, development of a single product combining the data integration technology with our INVOS System technology, development costs associated with advances to the design and performance features of the INVOS System, including the disposable sensor, development costs associated with our Contract Development Agreement with Shirley Research Corporation and the hiring of additional research and development personnel.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $3,896,936, or 17 percent, from $22,269,184 for the fiscal year ended November 30, 2007 to $26,166,120 for the fiscal year ended November 30, 2008, primarily due to:
• a $2,275,304 increase in salaries, wages, commissions and related expenses, primarily as a result of an increase in the number of employees, principally in sales and marketing (from an average of 88 employees for the fiscal year ended November 30, 2007 to an average of 105 employees for the fiscal year ended November 30, 2008) and an increase in salaries of existing employees;

• an $673,212 increase in travel, marketing and selling-related expenses as a result of our increased sales personnel and increased sales and marketing activities, including sales training and trade shows;

• a $557,282 increase in stock compensation expense due to stock compensation issued to our officers, employees, directors and one of our consultants in fiscal 2006, 2007 and 2008;

• a $465,769 increase in professional service fees, primarily due to increased legal, auditing and tax fees;

• a $217,099 increase in accrued incentive compensation expense due to our fiscal year 2008 financial performance, primarily increased sales and operating income in accordance with the 2008 incentive compensation plans; and

• a $173,672 increase in office and facility expenses primarily as a result of increased employees.

These increases were partially offset by a $273,905 decrease in commissions paid to our independent sales representative firms as a result of fewer independent sales representative firms in fiscal 2008, and a $182,919 decrease in clinical research expense primarily as a result of a grant made in fiscal 2007 for the support of neonatal research.

We expect our selling, general and administrative expenses to increase in fiscal 2009, primarily as a result of our hiring additional direct sales personnel in fiscal 2008 and 2009, increased employee sales commissions payable as a result of increased sales, increased sales and marketing expenses and increased stock compensation expenses.
Other Income. During fiscal 2008, interest income decreased to $2,629,967, from $4,008,537 in fiscal 2007, primarily due to decreased interest rates, decreased investment balances, and the use of cash for the repurchase of common shares, partially offset by our increased cash and cash equivalents balances as a result of cash provided by operating activities and maturities and redemptions of investments.
Income Taxes. As of November 30, 2008, we recognized income tax expense at an estimated effective tax rate of 36 percent on our statement of operations. In addition, during fiscal 2008 we recognized deferred tax assets related to the exercise of stock options of approximately $1,012,000. These assets were recognized in additional paid in capital on our balance sheet because they were utilized and reduced current taxes payable. As of November 30, 2007, we recognized income tax expense at an estimated effective tax rate of 35 percent on our statement of operations.
Fiscal Year Ended November 30, 2007 Compared to Fiscal Year Ended November 30, 2006
Net Revenues. Our net revenues increased $9,885,232, or 34 percent, from $28,700,600 in the fiscal year ended November 30, 2006 to $38,585,832 in the fiscal year ended November 30, 2007. The increase in net revenues is primarily attributable to:
• an increase in U.S. sales of $8,284,866, or 36 percent, from $23,276,064 in fiscal 2006 to $31,560,930 in fiscal 2007. The increase in U.S. sales was primarily due to an increase in sales of the disposable sensor of $5,691,400, or 30 percent, primarily as a result of a 24 percent increase in sensor unit sales. In addition, sales of the INVOS System monitor in the United States increased $2,841,360, or 75 percent, primarily as a result of increased purchases by pediatric hospitals; and

• an increase in international sales of $1,600,366, or 30 percent, from $5,424,536 in fiscal 2006 to $7,024,902 in fiscal 2007. The increase in international sales was primarily due to increased purchases of the INVOS System monitor and disposable sensors by Covidien, formerly Tyco Healthcare, in Europe, and increased purchases by Edwards Lifesciences in connection with the launch of our four-channel cerebral and somatic INVOS System monitor in Japan, partially for evaluation and demonstration purposes. In fiscal 2007, international sales represented 18 percent of our net revenues, compared to 19 percent of our net revenues in fiscal 2006. Purchases by Covidien accounted for 13 percent of net revenues in fiscal 2007, compared to 15 percent in fiscal 2006.

In the United States, we sold 248,360 sensors in fiscal 2007, and internationally, we sold 122,690. We placed 509 INVOS System monitors in the United States and 434 internationally in fiscal 2007, and our installed base of INVOS System monitors in the United States was 2,006, in 664 hospitals, as of November 30, 2007.
Sales of our products as a percentage of net revenues were as follows:

                                       Fiscal Year Ended November 30,
             Product                     2007                  2006
             Sensors                            73 %                  75 %
             INVOS System Monitors              27 %                  24 %

             Total INVOS System                100 %                  99 %
             Other                               0 %                   1 %

             Total                             100 %                 100 %

Gross Margin. Gross margin as a percentage of net revenues was 88 percent for the fiscal year ended November 30, 2007 and November 30, 2006. We realized a four percent increase in the average selling price of disposable sensors in the United States and increased sales of the INVOS System monitors to pediatric hospitals in

the United States. The increase in our average selling prices in the United States is attributable to increased sales of our pediatric sensor, which sells for a higher price than the adult sensor.
Research, Development and Engineering Expenses. Our research, development and engineering expenses decreased $913,706, or 58 percent, from $1,582,521 in fiscal 2006 to $668,815 in fiscal 2007. The decrease is primarily attributable to a $1,000,000 initial fee under our Contract Development and Exclusive Licensing Agreement entered into with NeuroPhysics Corporation in the fourth quarter of fiscal 2006.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $5,784,617, or 35 percent, from $16,484,567 for the fiscal year ended November 30, 2006 to $22,269,184 for the fiscal year ended November 30, 2007, primarily due to:
• a $2,575,653 increase in salaries, wages and related expenses, primarily as a result of an increase in the number of employees, principally in sales and marketing (from an average of 64 employees for the fiscal year ended November 30, 2006 to an average of 88 employees for the fiscal year ended November 30, 2007) and an increase in salaries of existing employees;

• an $1,200,884 increase in travel, marketing and selling-related expenses as a result of our increased sales personnel and increased sales and marketing activities, including sales training, product sponsorship, trade shows and advertising;

• an $1,147,564 increase in employee sales commissions as a result of increased sales and hiring additional sales employees in fiscal 2007;

• a $513,754 increase in accrued incentive compensation expense due to our fiscal year 2007 financial performance, primarily increased sales and operating income in accordance with the 2007 incentive compensation plans;

• a $477,060 increase in stock compensation expense due to stock compensation issued to directors, officers, employees and a consultant in fiscal 2006 and 2007;

• a $233,693 increase in clinical research expenses primarily as a result of a grant for neonatal research and a clinical trial evaluating the use of the INVOS System on diabetic patients over age 50; and

• a $165,935 increase in corporate insurance expenses due to increased coverage limits and increased premiums.

These increases were partially offset by a $739,400 decrease in commissions paid to our independent sales representative firms as a result of fewer independent sales representative firms in fiscal 2007.
Other Income. During fiscal 2007, interest income increased to $4,008,537, from $2,582,033 in fiscal 2006, primarily due to our increased cash, cash equivalents, marketable securities and long-term investment balances as a result of cash provided by operating activities and the proceeds from our public offering of common shares that closed in the second quarter of fiscal 2006, and increased interest rates.
Income Taxes. As of November 30, 2007, we recognized income tax expense at an estimated effective tax rate of 35 percent on our statement of operations, and we expect this to continue for future periods. As of November 30, 2006, we further adjusted our deferred tax asset valuation allowance resulting in the recognition of additional deferred tax assets as a result of expected future tax benefits related to our net operating loss carryforwards. Recognition of this additional deferred tax asset resulted in a non-cash tax benefit on our statement of operations for fiscal 2006 of $750,000, and increased our net income for fiscal 2006 to $10,399,957, or $0.75 per diluted common share. For fiscal 2006, the reversal of our valuation allowance was net of recorded taxes. The net income tax benefit of $750,000 consisted of income tax expense recorded at an estimated effective tax rate of 34 percent in the amount of $2,604,663 for the first three quarters of fiscal 2006, and a net deferred tax benefit of $3,354,663 recorded in the fourth quarter of fiscal 2006.
Effects of Inflation
We do not believe that inflation has had a significant impact on our financial position or results of operations in the past three years.

Liquidity and Capital Resources
General
Our principal sources of operating funds have been the proceeds from sales of our common shares and cash provided by operating activities. See Statements of Shareholders' Equity of our financial statements included elsewhere in this report.
As of November 30, 2008, we did not have any outstanding or available debt financing arrangements, we had working capital of $65.6 million and our primary sources of liquidity were $37.2 million of cash and cash equivalents, $20.0 million of marketable securities and $12.8 million of long-term investments. Marketable securities and long-term investments consist of Aaa-rated United States Government agency bonds and treasury bills, and cash and cash equivalents are currently invested in bank savings accounts and money market accounts, pending their ultimate use.
On March 6, 2006, we completed a public offering of 2,300,000 of our newly-issued common shares at a public offering price of $24.00 per share. The net proceeds, after deducting the underwriting discount and the expense of the offering, were $51,232,774.
In April 2008, our Board of Directors authorized the repurchase of up to $15 million of our common shares. Purchases may be made from time to time in the open market or in privately negotiated transactions. The prices, timing and amount of, and purposes for, any purchases will be determined by management. In May 2008, our Board of Directors authorized the repurchase of up to an additional $15 million of our common shares, and in July 2008, our Board of Directors authorized the repurchase of up to an additional $15 million of our common shares, for a total of $45 million of our common shares under the repurchase program. During fiscal 2008, we repurchased 1,805,129 common shares at an average price of $17.42 per share and an aggregate cost of $31,449,420, leaving $13,550,580 in dollar value of shares that may yet be purchased under the repurchase program.
In November 2008, we acquired substantially all of the assets of ICU Data Systems, Inc., a technology development company, for approximately $2,000,000 in cash plus the assumption of specified liabilities. ICU Data Systems has developed a patented technology that integrates data from a broad array of hospital bedside devices, such as physiological monitors, ventilators and infusion devices, into a single bedside display for comparison, data management and storage. We plan to further develop and launch our newly-acquired data integration technology as a stand-alone device in mid-2009. To support the addition of the derived parameter features to the system, we will pursue a new FDA 510(k) clearance in 2009. In addition, we expect to invest to combine the ICU Data Systems and INVOS System technologies in a single product for launch expected in the second half of 2010. We also plan to pursue a new FDA 510(k) clearance for this integrated device in 2010. We expect our research, development and engineering expenses to increase in fiscal 2009 as a result of development costs associated with development of our newly-acquired data integration technology as a stand-alone device and development of a single product combining the data integration technology with our INVOS System technology.
We entered into a Contract Development and Exclusive Licensing Agreement . . .